Slowly wean­ing Euro­zone off fi­nan­cial steroids may mean bad come­down later

Irish Independent - Business Week - - COMMERCIAL PROPERTY -

THE Euro­pean Cen­tral Bank de­cided last week to ex­tend its multi­bil­lion euro bond buy­ing pro­gramme for another nine months. The quan­ti­ta­tive eas­ing pro­gramme (QE) sees the ECB buy up around €60bn worth of gov­ern­ment, cor­po­rate and var­i­ous as­set-backed bonds in the mar­ket ev­ery month.

ECB head Mario Draghi is widely seen as hav­ing played things well last week but an­nounc­ing a re­duc­tion in the amount of monthly QE from €60bn to €30bn while man­ag­ing ex­pec­ta­tions and avoid­ing any shock or panic that this enor­mous fi­nan­cial steroid might be with­drawn in a hurry.

QE is loosely de­scribed as ‘print­ing money’, which im­me­di­ately has the con­no­ta­tions of hy­per­in­fla­tion and peo­ple hav­ing to take their weekly wages home in a wheel­bar­row, be­cause their money’s buy­ing power is di­min­ished.

While QE does in­volve cre­at­ing new money to buy these bonds, it isn’t nec­es­sar­ily dis­trib­uted through­out the whole econ­omy, through higher wages for ex­am­ple, and so far it has avoided cre­at­ing sig­nif­i­cant in­fla­tion.

But it doesn’t mean that it has not cre­ated an ar­ti­fi­cial­ity that could be­come very real when QE is fi­nally re­moved.

There have been sev­eral ben­e­fits to Ire­land from the ECB’s QE pro­gramme which be­gan in 2015. The ECB has bought up around 40pc of our na­tional debt. In do­ing so, it has out­bid other buy­ers of the debt, which has made it cheaper for the State to raise money.

The an­nual in­ter­est bill on our €200bn na­tional debt is due to fall from €9bn in 2014 to un­der €6bn by 2020. That in­volves pay­ing out €250m a week less in ser­vic­ing our na­tional debt.

The ECB pro­gramme has also shifted into buy­ing up cor­po­rate bonds. This has also re­duced the cost of debt for big in­ter­na­tional com­pa­nies such as Unilever, Rep­sol, Shell and Nes­tle.

Among Ir­ish com­pa­nies, it has bought Ryanair, Kerry and CRH bonds which have helped those com­pa­nies to re­fi­nance debt or bor­row to ac­quire new com­pa­nies at lower rates.

The QE pro­gramme has also seen tens of bil­lions spent buy­ing up as­set-backed se­cu­ri­ties which are like traded bonds backed up by pools of mort­gage or credit card debt.

Ac­com­pa­ny­ing the mas­sive as­set-buy­ing spree are record low in­ter­est rates. The ECB sig­nalled last week that it would not only con­tinue the QE pro­gramme un­til Septem­ber 2018 or longer if re­quired but that it would not put up in­ter­est rates un­til well af­ter the bond buy­ing stopped. This means we are highly un­likely to see an in­ter­est rate rise un­til 2019, pos­si­bly at the ear­li­est.

This also spells good news for mort­gage hold­ers or any­one else car­ry­ing debts that have to be ser­viced. The Ir­ish eco­nomic re­cov­ery has been fu­elled by a num­ber of be­nign ex­ter­nal fac­tors that are out­side our gov­ern­ment’s con­trol.

These in­clude low oil prices, low in­ter­est rates and a rel­a­tively cheap euro. The euro has risen sharply against ster­ling, fol­low­ing the Brexit ref­er­en­dum but for now at least, is hov­er­ing around the 88p mark in­stead of kick­ing on for par­ity.

Oil prices have gained but there is lit­tle sign of a sig­nif­i­cant and sus­tained oil price spike on the hori­zon un­less US pres­i­dent Don­ald Trump gets very trig­ger-happy with his mil­i­tary ar­se­nal.

Fears of in­ter­est rises prompted some mort­gage hold­ers to plump for fixed-term mort­gage rates for a few years. Bank of Ire­land in par­tic­u­lar was push­ing fixed rates as it re­fused to drop its stan­dard vari­able rates in line with com­peti­tors like AIB in re­cent years. Those who opted to fix in the last two years may have bought some peace of mind but it has come at a price, as rates are not likely to go up un­til at least 2019.

Nev­er­the­less, put all of these as­pects of last week’s ECB an­nounce­ment to­gether, and it does ap­pear to be good news for Ire­land. But is it?

The rea­son ECB chief Mario Draghi is keen to keep QE go­ing is be­cause he doesn’t be­lieve Euro­zone economies in gen­eral are ready to do with­out the fi­nan­cial sup­port it brings. Some of the big­ger ones are strug­gling to keep their bud­get deficits within Euro­zone rules. Coun­tries like Italy have struc­tural eco­nomic chal­lenges. Euro­zone growth is pick­ing up now but it re­mains frag­ile.

Fragility is not a word one might as­so­ci­ate with po­lit­i­cal eco­nomic rhetoric in Ire­land. Our econ­omy con­tin­ues to out­per­form the rest of Eu­rope in head­line growth terms and it could be ar­gued that it doesn’t need any more ar­ti­fi­cial stim­u­lus.

Does CRH need an ar­ti­fi­cially cre­ated lower bor­row­ing rate to help it fund ac­qui­si­tions in the US, In­done­sia or wher­ever? Does Ryanair need to have its bor­row­ing cost low­ered by ECB money when it says that a mas­sive pilot re­sourc­ing is­sue won’t dent this year’s prof­its?

How re­al­is­tic is it to think that the Ir­ish state can con­tinue to bor­row 10-year money at an in­ter­est rate or coupon of just 0.6pc?

The po­ten­tial prob­lem for Ire­land is al­ways the same when it comes to the ECB. As a tiny per­cent­age of Euro­zone GDP, our eco­nomic needs at a par­tic­u­lar time might not be best served by ECB de­ci­sions.

The same may well ap­ply as QE is wound down. Tim­ing and pac­ing will be ev­ery­thing. We could have a sit­u­a­tion where in 2019, the QE pro­gramme comes to an end and our sov­er­eign bor­row­ing costs rise sub­stan­tially. That year we could also see the UK crash out of the EU. It could also be the same year that in­ter­est rates start to go up for the first time in years.

This would have dra­matic con­se­quences for our hous­ing mar­ket, our stock mar­ket and our ex­che­quer fund­ing po­si­tion.

Thank­fully, the NTMA has suc­cess­fully pushed back debt re­fi­nanc­ing well into the fu­ture. The ma­tu­rity pro­file of our debt has been ex­tended by 11 years, the long­est among the EU28, where the pro­file is around seven years.

This would all help but equally our debt bur­den is sub­stan­tial. Our gen­eral gov­ern­ment debt is 275pc of gen­eral gov­ern­ment rev­enue, com­pared to an EU28 av­er­age of 165pc. In­ter­est pay­ments, at these his­tor­i­cally low and prob­a­bly un­sus­tain­able lev­els, are still 8pc of all gov­ern­ment rev­enue. That is twice the av­er­age for the EU28.

Draghi may have done us a favour last week, but per­haps only by post­pon­ing a bit of a reck­on­ing rather than avoid­ing it al­to­gether.

QE re­mains a con­tro­ver­sial cen­tral bank tool. It be­gan in the US in Novem­ber 2008 and lasted un­til 2014. Dur­ing that time it pushed up share prices, which ben­e­fited cer­tain sec­tions of Amer­i­can so­ci­ety in par­tic­u­lar.

Crit­ics say it has height­ened so­cial in­equal­ity. The idea is that if you don’t have much by way of as­sets you can­not ben­e­fit from its tar­geted stim­u­lus which bol­sters the price of bonds, eq­ui­ties and other as­set classes.

In the US, the Fed­eral Re­serve has said it will start sell­ing down some of the $4.6trn in as­sets it ac­quired through its QE pro­grammes. This could trig­ger a wob­ble in some as­set classes, in­clud­ing the stock mar­ket, if it is not very care­fully man­aged.

In Eu­rope, the ECB is still well be­hind reach­ing that day. It will con­tinue buy­ing up as­sets at €60bn per month un­til Jan­uary, and then at a rate of €30bn per month un­til Septem­ber 2018 at the ear­li­est.

It will also rein­vest the money it re­ceives in prin­ci­ple pay­ments from the as­sets it has al­ready ac­quired. It has bought up so much in Euro­zone gov­ern­ment bonds, it has been sug­gested that there isn’t that much qual­i­fy­ing state debt left to buy.

This should lead to a shift to­ward more cor­po­rate bond pur­chases as the pro­gramme en­ters 2018.

Per­haps the best way of putting is, that last week’s an­nounce­ment re­duces the chances of a short-term shock or crash, but in­creases the risks of some­thing bad a lit­tle fur­ther out.

How are we pre­par­ing for this in Ire­land? We are push­ing the Gov­ern­ment to cut taxes and spend more money, while we re­dis­cover our ap­petite for bor­row­ing – both per­sonal and cor­po­rate.

Surely some mis­take.

ECB boss Mario Draghi an­nounced last week that stim­u­lus would be halved to €30bn a month but for an ex­tended pe­riod un­til Septem­ber 2018

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